Turkey in Worst Emerging Bond Slump Not Enough to Lure Aviva

By Selcuk Gokoluk and Michael Patterson -
Nov 30, 2011

Turkish bond yields are rising
faster than the rest of emerging-market debt and still can’t
entice the world’s biggest investors, who say policy makers
won’t curb inflation unless they take steps to slow growth.

Yields on Turkish government two-year notes climbed to 10.9
percent yesterday from 8.4 percent at the end of September, the
largest increase among 16 developing nations tracked by JPMorgan
Chase & Co. Aviva Investors Ltd.’s Kieran Curtis says rates need
to reach 11.5 percent before he considers buying. Dmitri Barinov, a fund manager at Union Investment Privatfonds, is
waiting for 15 percent.

Money managers are concerned the worst is yet to come in
Turkey’s $196 billion fixed-income market because the central
bank has committed to fighting the 7.7 percent inflation rate
without raising benchmark borrowing costs, a policy Fitch
Ratings calls “unorthodox.” Yields increased more than in
Hungary, which Moody’s Investors Service cut to junk last week,
and Egypt, rocked by clashes between protesters and security
forces, according to data compiled by Bloomberg.

“Many investors haven’t been entirely comfortable with
monetary policy or convinced that these measures would
sufficiently slow domestic demand,” said Kjetil Birkeland, who
helps oversee about $11 billion in emerging markets as a Boston-based senior analyst at Standish Asset Management. “In an
environment when investors have a lot of risks to deal with,
this is another uncertainty.”

Europe’s Crisis

Turkey, the seventh-largest developing nation by gross
domestic product, faces the same challenges as other emerging
markets as Europe’s sovereign debt crisis slows the region’s
economy and reduces investor demand for riskier assets. What
makes Turkey different is the central bank’s attempt to stem the
fastest inflation in a year without damping GDP growth that
slowed to 8.8 percent in the second quarter from 11.6 percent in
the first three months of 2011.

Deputy Prime Minister Ali Babacan said in an interview with
Bloomberg HT television in London on Nov. 23 that a 4 percent
growth target for 2012 may be hit by the debt crisis. The
expansion may slow to 2.2 percent next year from 7.5 percent in
2011, Ed Parker, a London-based managing director at Fitch,
wrote in an e-mailed statement. Developing economies will
probably expand 6.1 percent in 2012, down from 6.4 percent this
year, according to September estimates from the International
Monetary Fund in Washington.

Policy Shift

Foreign funds that doubled holdings of Turkish government
bonds to a record $44 billion in the 12 months through April
have since cut their investments by $8.7 billion, according to
the central bank. Investors withdrew as inflation exceeded the
central bank’s target and policy makers introduced a dual
interest-rate system to reduce lending, support the lira and
shield Turkey’s economy from Europe’s woes.

European Union countries purchased 47 percent of Turkish
exports this year through September, up from 46 percent in 2010,
according to government data. The euro area has entered a
“mild” recession and may expand 0.2 percent in 2012, the
Paris-based Organization for Economic Cooperation and
Development said on Nov. 28.

Instead of raising the one-week repurchase rate from a
record low 5.75 percent to drain money from the economy, Central
Bank of Turkey Governor Erdem Basci said on Oct. 26 that policy
makers will vary banks’ borrowing costs daily between the
benchmark and an overnight rate of as much as 12.5 percent.

Since then, the central bank has lent about 188 billion
liras ($102 billion) at the lower level and about 119 billion at
the higher rates, according to its website.

Current-Account Gap

Yields on Turkey’s two-year debt fell 46 basis points to
10.4 percent today after China cut banks’ reserve requirements
for the first time since 2008 and six central banks acted
together to make additional funds available to ease strains from
Europe’s debt crisis. The lira strengthened 1.3 percent against
the dollar.

“It is difficult to predict and understand” where
interest rates will be, said Tim Ash, the head of emerging-market research at Royal Bank of Scotland Group Plc in London.

Policy makers face a “very delicate balance,” Babacan
said in an Oct. 26 interview in London. “On one hand, inflation
is very important, so we don’t want to hurt our inflation
targets. But meanwhile we don’t want to fall into a recession.”

Higher Yields

The strategy has confused investors. Fitch cut the outlook
on Turkey’s BB+ credit rating, one step below investment grade,
to stable from positive on Nov. 23. Bonds rated below BBB- at
Fitch and S&P, or below Baa3 at Moody’s, are called junk
securities.

The current-account deficit, the second-highest worldwide
after the U.S., will grow to 9.8 percent of GDP (TUGPCOYR) this year from
6.5 percent last year, Fitch’s Parker said. Policy makers will
miss their inflation target for the fourth time in six years as
the rate rises to 9.2 percent, he said.

Investors are waiting for yields to climb to 12.4 percent
before buying, according to the average of five estimates by
money managers and strategists surveyed by Bloomberg News.

“We prefer a more stable framework for monetary policy”
that includes a higher benchmark interest rate, said Curtis, a
London-based emerging-market money manager at Aviva, which
oversees about $420 billion. “If there was more certainty about
policy they would be good value. Unless we get that, it will
take higher yields for us to buy.”

Lira Bulls

The central bank declined to comment on interest rates and
the lira in an e-mail to Bloomberg News.

Higher yields in Turkey relative to other emerging markets
and forecasts for a stronger currency may attract buyers,
according to Ismail Erdem, who helps oversee the equivalent of
$2.7 billion as regional director for the Middle East and North
Africa at Taaleritehdas Fund Management Co. in Helsinki.

“Foreign capital will buy bonds in a country with an
appreciating currency and 10 percent yields,” he said. “I have
a positive view of Turkish bonds for the medium term.”

Turkish yields were 416 basis points, or 4.16 percentage
points, higher than the rate on JPMorgan’s gauge of local-currency emerging-market debt as of Nov. 28, the widest gap
since July 2009. Rates on two-year notes are 321 basis points
above the inflation rate, compared with an average of 599 basis
points since April 2005, data compiled by Bloomberg show.

Greece, Spain

In Hungary, where the government has requested financial
aid from the IMF and local-currency debt has the same BBB-rating
from Standard & Poor’s as Turkey, yields have climbed to 8.8
percent from 7 percent in September.

One-year bills in Egypt, rated four steps below Turkey at
S&P, increased to 14.9 percent from 13.9 percent two months ago.
Fighting in Cairo between protesters and security forces
threatened to disrupt elections this week.

Yields on two-year debt of Greece, which is in talks with
bondholders over a potential 50 percent writedown, have surged
to 130 percent from 62 percent at the end of September,
according to data compiled by Bloomberg. Italy’s two-year notes
yield 7.1 percent while Spanish debt yields 5.6 percent.

Turkish policy makers set the stage for higher rates by
cutting the repo rate three times from 7 percent a year ago, the
most of any major developing economy, to weaken the lira and
narrow the record current-account deficit.

Faster Inflation

The 12-month gap widened to $77.5 billion in September
because of high oil prices, “unnecessarily strong domestic
demand” and falling exports to Middle Eastern countries hit by
social unrest, Finance Minister Mehmet Simsek said in televised
remarks to journalists in Ankara on Nov. 15.

Prime Minister Recep Tayyip Erdogan endorsed the cuts in a
May 3 speech in Istanbul where he said interest rates should be
close to zero after inflation. He told parliament in July that
the central bank would “continue to decide on its monetary
policy in an independent manner.”

Lower rates succeeded in weakening the lira, which
depreciated about 19 percent since December to an all-time low
of 1.91 to the dollar last month. At the same time, reduced
purchasing power increased inflation in October above the
central bank’s 5.5 percent target. Consumer price inflation may
end the year at 8.3 percent, according to the central bank. The
government projects CPI will slow to between 5 percent and 6
percent next year, said Babacan, the deputy prime minister.

‘Early Phase’

“The inflation outlook does not look bond-friendly,” said
Barinov, a Frankfurt-based money manager at Union Investment,
which oversees about $225 billion. “To increase exposure I need
to see more decisive measures” from the central bank, he said.

Policy makers have changed tactics and are supporting the
lira, spending about $9 billion to back the currency since
August. Foreign-exchange reserves have declined 9.2 percent from
this year’s high in July to $85 billion as of Nov. 18.

There’s “fundamentally no room” for the lira to weaken,
Governor Basci said at an Oct. 21 conference in Warsaw. The
currency is “slightly undervalued,” he said in Ankara on Oct.
26, when the lira traded at 1.7581 against the dollar, or about
5.3 percent stronger than the level yesterday.

Now, expectations for tighter policy are increasing. The
lira will strengthen 12 percent against the dollar within a
year, according to the median of 18 analyst forecasts compiled
by Bloomberg. Including interest rates, the currency would
return 23 percent, the most of any developing currency after
Poland’s zloty, the data show.

“When rates go up high enough for the currency and
inflation to have stabilized, at that point people will come
back into bonds,” said Amer Bisat, a money manager at hedge
fund Traxis Partners LP in New York and former senior economist
at the IMF. “But I don’t think we’re there yet. We’re still in
the early phase.”